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The Evolution of the Securitized Market

Henry Song, CFA

The securitized market has a lot of inefficiencies that can be exploited. Learn about how this market has evolved over the years and the new and interesting investment opportunities it offers fixed income investors today.

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The following text is a transcript of portions of the speakers’ podcast originally recorded in July 2021. This transcript solely represents the views of the individuals who spoke, which are subject to change.

The Evolution of the Securitized Market

Douglas Gimple, Senior Portfolio Specialist:

So Henry, I'll gear this question towards you, our strategies from short to intermediate to core tend to focus on securitized as a way of delivering excess return to clients. Short duration in particular is fairly unique and it's universe with such a heavy focus on the securitized market. What was the thought process around launching and designing this product and how has it fared since its launch in 2016?

Henry Song, CFA, Portfolio Manager:

Yeah, the securitized market's always been interesting. Historically, we had an overweight in the securitized space. Mark talked about earlier, the creation of a CMO market in the early eighties. There were just a lot of inefficiencies in that space. I think if you just look at a sheer number of CUSIP's available in the space just makes it very, well because when you think about mortgage, you can essentially indefinitely slice and dice into different cash flows, different tranches. So that makes it interesting and also makes it hard for new technology to come into the space to disrupt it. I've talked about electronic trading in the corporate space, that doesn't really exist in the mortgage space.

As the market continued to evolve, especially in post 2008, we've seeing some newer asset classes coming to the market. I think some of the catalysts were, for example, GE was broken up, GE Capital. They did a lot of this stuff on the balance sheets before and now they come to the asset backed securities market, financing various securities. So we found a lot of attractive new asset classes coming to the market that weren't exactly accepted by most of the investors initially. And we continue to see more of that happening now.

So, for example, in the green revolution, we're talking about now, we started seeing solar panels, Tesla start securitizing their deals, which is all just very different than what has been in the market historically. So all of that just creates a lot of opportunities. And to us, when we look back, it just never made sense why something that has so much more enhancement gets worse rating oftentimes than their corporate counterparts and trading on much wider spreads. We really contribute that to something that's in early stage of development, not massively popular and not being part of the index really also hurts it as well.

But on the flip side, there are less disruption or if you call, sometimes you can think about it as a manipulation because when the index people started buying it, then the value really erodes away very quickly.

So, it's done well, the short duration strategy you mentioned has a pretty unique proposition where it's 80% plus in securitized products, we have held a pretty steady yield advantage over the benchmark over the last five years, roughly around 200 basis points in that five-year time span. And so, I think that has proven that it works really well in this space. Certainly, like we talked about last March, had its fair of challenges when liquidity dried up in the space, but outside of that one episode has held up extremely well. And I think that provided a lot of value for people who have a longer time investment horizon and who can stomach a little bit of volatility.

The views expressed are those of the portfolio manager as of July 2021, are subject to change, and may differ from the views of other portfolio managers, research analysts or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results.

The Bloomberg U.S. Aggregate Index is an unmanaged index representing the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through, and asset-backed securities.

As of June 30, 2021, Diamond Hill owned debt in Tesla Auto Lease Trust.

Click here for Short Duration Securitized Bond strategy performance.

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